GATES INDUSTRIAL CORPORATION PLC The following discussion should be read in conjunction with the condensed consolidated financial statements and related notes thereto included elsewhere in this quarterly report. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from management's expectations. Factors that could cause such differences are discussed in "Forward-Looking Statements" above, Item 1A. "Risk Factors" in Part II of our annual report and Item 1A. "Risk Factors" in Part I of our Quarterly Report on Form 10-Q for the period endedMarch 28, 2020 Our Company We are a global manufacturer of innovative, highly engineered power transmission and fluid power solutions. We offer a broad portfolio of products to diverse replacement channel customers and to original equipment ("first-fit") manufacturers as specified components, with the majority of our revenue coming from replacement channels. Our products are used in applications across numerous end markets, which include construction, agriculture, energy, automotive, transportation, general industrial, consumer products and many others. We sell our products globally under the Gates brand, which is recognized by distributors, equipment manufacturers, installers and end users as a premium brand for quality and technological innovation; this reputation has been built for over a century since Gates' founding in 1911. Within the diverse end markets we serve, our highly engineered products are often critical components in applications for which the cost of downtime is high relative to the cost of our products, resulting in the willingness of end users to pay a premium for superior performance and availability. These applications subject our products to normal wear and tear, resulting in a natural replacement cycle that drives high-margin, recurring revenue. Our product portfolio represents one of the broadest ranges of power transmission and fluid power products in the markets we serve, and we maintain long-standing relationships with a diversified group of blue-chip customers throughout the world. As a leading designer, manufacturer and marketer of highly engineered, mission-critical products, we have become an industry leader across most of the regions and end markets in which we operate. Business Trends Our net sales have historically been, and remain, highly correlated with industrial activity and utilization and not with any single end market given the diversification of our business and high exposure to replacement channels. This diversification limits our exposure to trends in any given end market. In addition, a majority of our sales are generated from customers in replacement channels, who serve primarily a large base of installed equipment that follows a natural maintenance cycle that is somewhat less susceptible to various trends that affect our end markets. Such trends include infrastructure investment and construction activity, agricultural production and related commodity prices, commercial and passenger vehicle production, miles driven and fleet age, evolving regulatory requirements related to emissions and fuel economy and oil and gas prices and production. Key indicators of our performance include industrial production, industrial sales and manufacturer shipments. During the six months endedJune 27, 2020 , sales into replacement channels accounted for approximately 65% of our total net sales. Our replacement sales cover a very broad range of applications and industries and, accordingly, are highly correlated with industrial activity and utilization and not a single end market. Replacement products are principally sold through distribution partners that may carry a very broad line of products or may specialize in products associated with a smaller set of end market applications. During the six months endedJune 27, 2020 , sales into first-fit channels accounted for approximately 35% of our total net sales. First-fit sales are to a variety of industrial and automotive customers. Our industrial first-fit customers cover a diverse range of industries and applications and many of our largest first-fit customers manufacture construction and agricultural equipment. Among our automotive first-fit customers, a majority of our net sales are to emerging market customers, where we believe our first-fit presence provides us with a strategic advantage in developing those markets and ultimately increasing our higher margin replacement channel sales. First-fit automotive sales in developed markets represented approximately 6% of our total net sales for the six months endedJune 27, 2020 , with first-fit automotive sales inNorth America contributing less than 3% of total net sales. As a result of the foregoing factors, we do not believe that our historical consolidated net sales have had any meaningful correlation to global automotive production but are positively correlated to industrial production. 29 -------------------------------------------------------------------------------- Table of Contents Our recently completed manufacturing footprint investments and other productivity improvements in recent years have helped to position us to continue to make progress on our restructuring program, which is primarily intended to optimize our manufacturing and distribution footprint over the mid-term by removing structural fixed costs and, to a lesser degree, to streamline our selling, general and administrative ("SG&A") back-office functions. We anticipate that most of the costs associated with these actions will be incurred during 2020 and 2021. Some of these costs will, in accordance withU.S. GAAP, be classified in cost of sales, negatively impacting gross margin, but due to their nature and impact of hindering comparison of the performance of our businesses on a period-over-period basis or with other businesses, they will be excluded from Adjusted EBITDA, consistent with the treatment of similar costs in the current and prior years. Impact of COVID-19 Pandemic The first quarter of 2020 marked the beginning of an unprecedented environment for the global economy, which has continued through the second quarter of 2020, as governments, companies and communities implemented strict measures to minimize the spread of COVID-19. We are prioritizing the health and safety of our employees and the communities in which we operate around the world, taking additional protective measures in our plants to safely maintain operational continuity in support of our global customer base. In early February, as our business inChina was being impacted, we mobilized a centralized crisis response team that developed and is tactically engaged in the implementation of our countermeasure actions across our global footprint. We are adhering to local government mandates and guidance provided by health authorities and have proactively implemented quarantine protocols, social distancing policies, working from home arrangements, travel suspensions, frequent and extensive disinfecting of our workspaces, provision of personal protective equipment, and mandatory temperature monitoring at our facilities. We expect to continue implementing these measures and we may take further actions if required or recommended by government authorities or if we determine them to be in the best interests of our employees, customers, and suppliers. Our operations are supported largely by local supply chains. Where necessary, we have taken steps to qualify additional suppliers to ensure we are able to maintain continuity of supply. Although we have not experienced any significant disruptions to date, certain Gates suppliers have, or may in the future, temporarily close operations, delay order fulfillment or limit production due to the pandemic. Continued disruptions, shipping delays or insolvency of key vendors in our supply chain could make it difficult or more costly for us to obtain the raw materials or other inputs we need for our operations. Gates employs an in-region, for-region manufacturing strategy, under which local operations primarily support local demand. In those cases where local production supports demand in other regions, contingency plans have been activated as appropriate. In addition to the handful of plants that were temporarily closed by government mandates, we have proactively managed our output to expected demand levels and occasionally suspended production at other plants for short periods of time. We may continue to experience these production disruptions, which could place constraints on our ability to produce our products and meet customer demand. Of these temporary closures in the first half of 2020, the most significant for us was inGreater China , where we closed all of our production facilities for approximately three weeks, and inIndia , where our facilities were closed for approximately six weeks. We have since safely returned these plants to more normalized capacity. Our two largest regions ofEurope andNorth America did not begin to see an impact from COVID-19 until late March. With large portions of the economies in these regions having effectively been shut down since the beginning ofApril 2020 , we experienced significant year-over-year revenue declines most sharply in April, with significant month-over-month improvements in May and June. As shelter-in-place requirements have eased in various jurisdictions, unfortunately accompanied in some cases by increases in affected individuals, there is continued progress in the fight against COVID-19, and we expect the second half of the year to improve sequentially from the second quarter. Given the magnitude of the decline we experienced in the first half of the year and the different rates of demand recovery we believe we will see across different end markets and geographies, we expect the full year to result in a revenue decline compared with the prior year. Reflecting the progress we have made recently in right-sizing the business, and in managing our cost structure in response to COVID-19, we would expect our full-year decremental margin to be an improvement from what we saw in 2019, despite the significant decline in revenue as a result of the pandemic. During this crisis, we have maintained our ability to respond to demand improvements, and while we have limited new capital expenditure, we continue to fund key initiatives, which we believe will serve us well as our end markets continue to recover. We have strength and flexibility in our liquidity position, which includes committed borrowing headroom of$415.3 million under our lines of credit (none of which are currently expected to be drawn in the foreseeable future), in addition to cash balances of$639.7 million as ofJune 27, 2020 . Our business also has a demonstrated ability to generate free cash flow even in challenging environments. 30 -------------------------------------------------------------------------------- Table of Contents As a result of the unpredictable and evolving impact of the pandemic and measures being taken around the world to combat its spread, the timing and trajectory of the recovery remain unclear at this time, and the adverse impact of the pandemic on Gates' operations may continue to be material. In addition, see Item 1A. "Risk Factors" in Part II of the Company's Quarterly Report on Form 10-Q for the period endedMarch 28, 2020 for an update to our risk factors regarding risks associated with the COVID-19 pandemic. Despite this highly uncertain environment, our early experience inChina , and more recent experience inNorth America and EMEA, has helped frame our response to this crisis and our focus in the remainder of 2020 will continue to be on: •safely supporting our employees, customers and the communities in which we operate; •actively managing what we can control in terms of our supply chains and operations; •managing our compressible costs to the prevailing demand conditions by tightly controlling discretionary spending; and •funding our key growth initiatives to enhance our differentiation in the market and allow us to emerge from this downturn in an even stronger competitive position. Results for the three and six months endedJune 27, 2020 compared with the results for the three and six months endedJune 29, 2019 Summary Gates Performance Three months ended Six months ended (dollars in millions) June 27, 2020 June 29, 2019 June 27, 2020 June 29, 2019 Net sales$ 576.5 $ 809.9 $ 1,286.6 $ 1,614.8 Cost of sales 373.0 508.5 827.3 1,006.1 Gross profit 203.5 301.4 459.3 608.7 Selling, general and administrative expenses 182.9 198.0 376.3 398.5 Transaction-related income - (0.7) (0.2) (0.3) Asset impairments 3.7 - 3.7 - Restructuring expenses 17.2 0.3 19.1 3.6 Other operating (income) expenses (3.7) 1.9 (1.4) 4.8 Operating income from continuing operations 3.4 101.9 61.8 202.1 Interest expense 34.3 39.2 71.0 77.3 Other income (3.7) (1.5) (5.8) (4.8) (Loss) income from continuing operations before taxes (27.2) 64.2 (3.4) 129.6 Income tax expense (benefit) 0.6 37.5 (15.5) (502.2)
Net (loss) income from continuing operations
26.7 $ 12.1 $ 631.8
Adjusted EBITDA(1) $ 83.2 $ 165.4 $ 204.0 $ 330.9
Adjusted EBITDA margin 14.4 % 20.4 % 15.9 % 20.5 %
(1) See "-Non-GAAP Measures" for a reconciliation of Adjusted EBITDA to net
income from continuing operations, the closest comparable GAAP measure, for each
of the periods presented.
Net sales
Net sales during the three months ended June 27, 2020 were $576.5 million , down
by 28.8%, or $233.4 million , compared with net sales during the prior year
period of $809.9 million . Our net sales in the three months ended June 27, 2020
were adversely impacted by movements in average currency exchange rates of
$19.8 million compared with the prior year period, due principally to the
strengthening of the U.S. dollar against a number of currencies, in particular
the Brazilian Real and Mexican Peso. Excluding this impact, core sales decreased
by $213.6 million , or 26.4%, during the three months ended June 27, 2020
compared with the prior year period, driven almost exclusively by lower volumes.
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This decline, predominantly a function of the economic impact from the COVID-19
pandemic, occurred across all of our sales channels, with core sales to
automotive and industrial customers down by $101.6 million and $111.8 million ,
respectively, compared with the prior year period. Regionally, North America and
EMEA drove the majority of the decline, decreasing by $109.4 million and $60.4
million , respectively compared with the prior year period. Sales to Industrial
First-Fit customers in North America comprised the majority of that region's
decline, decreasing by 37.8% compared with the prior year period, while sales to
all EMEA channels decreased by roughly the same amount in dollar terms.
Partially offsetting these declines was modest growth in Greater China , which
was up by 1.8% compared with the prior year period, driven primarily by sales
into the Industrial First-Fit channel, which grew by 13.5% compared with the
prior year period. Construction was our weakest end market during the quarter,
declining by 36.7% during the three months ended June 27, 2020 , compared with
the prior year period, while the Agriculture and General Industrial end markets
declined more moderately at 12.6% and 17.2%, respectively, compared with the
prior year period. Industrial end markets in our developed markets were
generally more significantly impacted by the economic downturn, while sales into
the Automotive end market decreased more significantly in emerging markets,
declining by 32.2% during the three months ended June 27, 2020 compared with the
prior year period.
Net sales during the six months ended June 27, 2020 were $1,286.6 million , down
by 20.3%, or $328.2 million , compared with net sales during the prior year
period of $1,614.8 million . Our net sales for the six months ended June 27, 2020
were adversely impacted by movements in average currency exchange rates of
$33.5 million compared with the prior year period, due principally to the
strengthening of the U.S. dollar against a number of currencies, in particular
the Brazilian Real, Euro, Chinese Renminbi, and Mexican Peso. Excluding these
impacts, core sales decreased by $294.7 million , or 18.2%, during the six months
ended June 27, 2020 compared with the prior year period, driven almost
exclusively by lower volumes.
Similar to the quarter, this decline in core sales was driven by the impacts
from the COVID-19 pandemic and adversely affected sales to customers across all
of our channels. The most significant decline in dollar terms was in North
America , which decreased by $145.5 million during the six months ended June 27,
2020 compared with the prior year period, driven by weaker industrial sales,
particularly in the construction end market, which was lower by 24.0% in the six
months ended June 27, 2020 compared with the prior year period. Sales in EMEA
and East Asia & India declined by $66.1 million and $42.6 million , respectively,
during the six months ended June 27, 2020 compared with the prior year period,
in both cases driven primarily by weaker sales in the automotive end market.
Cost of sales
Cost of sales for the three months ended June 27, 2020 was $373.0 million , a
decrease of 26.6%, or $135.5 million , compared with $508.5 million for the prior
year period. The decrease was driven primarily by lower volumes of
$121.5 million , a function of the lower production due to a combination of weak
demand and production facility closures resulting from the COVID-19 pandemic, in
addition to favorable movements in average currency exchange rates of
$9.6 million .
Cost of sales for the six months ended June 27, 2020 was $827.3 million , a
decrease of 17.8%, or $178.8 million , compared with $1,006.1 million for the
prior year period. Similar to the quarter, the decrease was driven primarily by
lower volumes of $172.7 million .
Gross profit
Gross profit for the three months ended June 27, 2020 was $203.5 million , down
32.5% from $301.4 million for the prior year period. The decrease was driven
primarily by the decreases in volumes of $90.9 million , combined with
unfavorable net impacts of movements in average currency exchange rates of $10.2
million . Our gross profit margin dropped by 190 basis points to 35.3% for the
three months ended June 27, 2020 , compared with 37.2% for the prior year period,
reflecting primarily the lower absorption of fixed costs on lower production
volumes.
Gross profit for the six months ended June 27, 2020 was $459.3 million , down
24.5% from $608.7 million for the prior year period, for similar reasons to
those outlined for the quarter above. Our gross profit margin dropped by 200
basis points to 35.7% for the six months ended June 27, 2020 , compared with
37.7% for the prior year period, reflecting the lower absorption of fixed costs
on lower production volumes.
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Selling, general and administrative expenses
SG&A expenses for the three months ended June 27, 2020 were $182.9 million
compared with $198.0 million for the prior year period. This decrease of
$15.1 million was driven by lower travel and entertainment costs of $5.0
million , $4.8 million of favorable impacts from movements in average currency
exchange rates and $4.8 million of lower variable costs related to decreased
volumes.
SG&A expenses for the six months ended June 27, 2020 were $376.3 million
compared with $398.5 million for the prior year period. This decrease of
$22.2 million was driven primarily by lower travel, entertainment and marketing
costs of $9.0 million , $6.6 million of lower variable costs related to decreased
volumes, and $4.4 million of favorable impacts from movements in average
currency exchange rates.
Transaction-related income
No transaction-related expenses were incurred during the three months ended
June 27, 2020 . Net transaction-related income of $0.7 million was recognized
during the prior year period, related primarily to the release of an accrual
from a prior period acquisition.
Transaction-related income for the six months ended June 27, 2020 was
$0.2 million compared with net income of $0.3 million for the prior year period.
The amounts in both periods related primarily to terminated or prior period
acquisition activity.
Restructuring expenses
As described further under "Business Trends" above, we have accelerated and
expanded upon our previously announced restructuring program, which is primarily
intended to optimize our manufacturing and distribution footprint over the
mid-term by removing structural fixed costs, and, to a lesser degree, to
streamline our SG&A back-office functions.
Restructuring expenses of $22.3 million and $24.2 million were recognized during
the three and six months ended June 27, 2020 , relating primarily to the June
2020 announcement of plans to close a manufacturing facility in Korea , the
closure of two North American manufacturing facilities and reductions in
workforce, primarily in the U.S. , Mexico and Greater China . The closure of the
Korean facility, the most significant restructuring activity during the period,
resulted in an accrual for severance costs of $12.8 million , an impairment of
inventory of $1.4 million (recognized in cost of sales) and an impairment of
fixed assets of $3.6 million , included in the asset impairments line in the
unaudited condensed consolidated statement of operations.
Restructuring expenses of $0.6 million and $3.9 million were recognized during
the prior year three and six month periods, respectively, related primarily to
the closure of one of our facilities in France and a strategic restructuring of
part of our Asian business.
Interest expense
Our interest expense was as follows:
Three months ended Six months ended
(dollars in millions) June 27, 2020 June 29, 2019 June 27, 2020 June 29, 2019
Debt:
Dollar Term Loan $ 16.3 $ 21.2 $ 35.1 $ 41.9
Euro Term Loan 5.7 5.5 11.4 11.1
Dollar Senior Notes 8.8 8.4 17.6 17.0
Other loans 0.1 0.3 0.1 0.3
30.9 35.4 64.2 70.3
Amortization of deferred issuance costs 2.5 3.0 4.9 5.5
Other interest expense 0.9 0.8 1.9 1.5
$ 34.3 $ 39.2 $ 71.0 $ 77.3
Details of our long-term debt are presented in note 12 to the condensed
consolidated financial statements included elsewhere in this report. Interest on
debt for the three and six months ended June 27, 2020 decreased when compared
with the equivalent prior year period due primarily to the lower interest rates
applicable on the floating rate Dollar Term Loan.
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Other income
Our other income was as follows:
Three months ended Six months ended
(dollars in millions) June 27, 2020 June
29, 2019
$ (0.7) $
(1.1)
(2.2) 0.3 (1.9) (0.6)
Net adjustments related to post-retirement
benefits (0.7) (0.6) (1.2) (1.9)
Other (0.1) (0.1) - (0.1)
$ (3.7) $ (1.5) $ (5.8) $ (4.8)
Other income for the three and six months ended June 27, 2020 was $3.7 million
and $5.8 million , compared with $1.5 million and $4.8 million , respectively, in
the prior year periods. These changes were driven primarily by net movements in
foreign currency exchange rates on net debt and hedging instruments, in addition
to, in the six months ended June 29, 2019 , a $0.7 million settlement gain
recognized in relation to the closure of one of our facilities in France .
Income tax expense
We compute the year-to-date income tax provision by applying our estimated
annual effective tax rate to our year-to-date pre-tax income and adjust for
discrete tax items in the period in which they occur.
For the three months ended June 27, 2020 , we had an income tax expense of
$0.6 million on pre-tax loss of $27.2 million , which resulted in an effective
tax rate of (2.2)%, compared with an income tax expense of $37.5 million on
pre-tax income of $64.2 million , which resulted in an effective tax rate of
58.4% for the three months ended June 29, 2019 .
For the six months ended June 27, 2020 , we had an income tax benefit of $15.5
million on pre-tax loss of $3.4 million , which resulted in an effective tax rate
of 455.9%, compared with an income tax benefit of $502.2 million on pre-tax
income of $129.6 million , which resulted in an effective tax rate of (387.5)%
for the six months ended June 29, 2019 .
The decrease in the effective tax rate for the three months ended June 27, 2020
compared with the prior year period was due primarily to the recognition in the
prior year of a discrete tax expense of $25.3 million related to revaluing our
deferred tax assets to reflect the reduction in the Luxembourg corporate tax
rate from 18% to 17%. In addition, during the three months ended June 27, 2020 ,
we incurred $18.5 million of non-operating costs for which no tax benefit was
recognized, whereas there were no similar costs incurred in the prior year
period.
The increase in the effective tax rate for the six months ended June 27, 2020
compared with the prior year period was due primarily to the recognition in the
prior year of a discrete benefit of $610.6 million related to the release of
valuation allowances, mainly related to Luxembourg net operating losses,
partially offset by a discrete expense of $65.1 million related to unrecognized
tax benefits resulting primarily from the European business reorganization, and
by a discrete tax expense of $25.3 million related to the reduction in the
Luxembourg corporate tax rate. The current year rate is driven mainly by
discrete tax benefits of $24.7 million , related to the reversal of unrecognized
tax benefits, net of settlement amounts, arising from the resolution of audits
in Canada and Germany and $3.2 million from law changes in India with respect to
the taxation of dividends. These current period benefits were offset partially
by $6.3 million of discrete expenses arising from the enactment in the U.S. of
the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act"). In
addition, during the six months ended June 27, 2020 , we incurred $18.5 million
of non-operating costs for which no tax benefit was recognized, whereas there
were no similar costs incurred in the prior year period.
Deferred Tax Assets and Liabilities
We recognize deferred tax assets and liabilities for future tax consequences
arising from differences between the carrying amounts of existing assets and
liabilities under U.S. GAAP and their respective tax bases, and for net
operating loss carryforwards and tax credit carryforwards. We evaluate the
recoverability of our deferred tax assets, weighing all positive and negative
evidence, and are required to establish or maintain a valuation allowance for
these assets if we determine that it is more likely than not that some or all of
the deferred tax assets will not be realized. The weight given to the evidence
is commensurate with the extent to which the evidence can be objectively
verified. If negative evidence exists, positive evidence is necessary to support
a conclusion that a valuation allowance is not needed.
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Our framework for assessing the recoverability of deferred tax assets requires
us to weigh all available evidence, including:
•taxable income in prior carry back years if carry back is permitted under the
relevant tax law;
•future reversal of existing temporary differences;
•tax-planning strategies that are prudent and feasible; and
•future taxable income exclusive of reversing temporary differences and
carryforwards.
As of each reporting date, management considers new evidence, both positive and
negative, that could impact our view with regard to the future realization of
deferred tax assets. We will maintain our positions with regard to future
realization of deferred tax assets, including those with respect to which we
continue maintaining valuation allowances, until there is sufficient new
evidence to support a change in expectations. Such a change in expectations
could arise due to many factors, including those impacting our forecasts of
future earnings, as well as changes in the international tax laws under which we
operate and tax planning. It is not reasonably possible to forecast any such
changes at the present time, but it is possible that, should they arise, our
view of their effect on the future realization of deferred tax assets may impact
materially our financial statements.
Significant Events
On March 27, 2020 , the CARES Act was enacted and signed into law in the U.S. in
response to the COVID-19 pandemic. One of the provisions of this law is an
increase to the allowable business interest deduction from 30% of adjusted
taxable income to 50% of adjusted taxable income for the 2019 and 2020 tax
years. This modification significantly increases the current deductible interest
expense of the Company for both years, which will result in a cash benefit while
increasing our effective tax rate through requirements to allocate and apportion
interest expense for certain other tax purposes, including in determining our
global intangible low-taxed income inclusion, deduction for foreign derived
intangible income, and the utilization of foreign tax credits.
Adjusted EBITDA
Adjusted EBITDA for the three months ended June 27, 2020 was $83.2 million , a
decrease of 49.7% or $82.2 million , compared with the prior year period Adjusted
EBITDA of $165.4 million . The Adjusted EBITDA margin was 14.4% for the three
months ended June 27, 2020 , a 600 basis point decrease from the prior year
period margin of 20.4%. The decrease in Adjusted EBITDA was driven primarily by
a $86.1 million impact from reduced volumes as described above.
Adjusted EBITDA for the six months ended June 27, 2020 was $204.0 million , a
decrease of 38.3% or $126.9 million , compared with Adjusted EBITDA of
$330.9 million for the prior year period. Adjusted EBITDA margin was 15.9% for
the six months ended June 27, 2020 , a 460 basis point decrease from the prior
year period margin of 20.5%. Similar to the quarter, the decrease in Adjusted
EBITDA was driven primarily by the impact from reduced volumes.
For a reconciliation of net income to Adjusted EBITDA for each of the periods
presented and the calculation of the Adjusted EBITDA margin, see "-Non-GAAP
Measures."
Analysis by Operating Segment
Power Transmission (64.2% and 63.0%, respectively, of Gates' net sales for the
three and six months ended June 27, 2020 )
Three months ended
(dollars in millions) June 27, 2020 June 29, 2019 Period over period change
Net sales $ 370.0 $ 501.5 (26.2 %)
Adjusted EBITDA $ 57.7 $ 105.6 (45.4 %)
Adjusted EBITDA margin 15.6 % 21.1 %
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Six months ended
(dollars in millions) June 27, 2020 June 29, 2019 Period over period change
Net sales $ 811.2 $ 1,001.0 (19.0 %)
Adjusted EBITDA $ 137.2 $ 215.5 (36.3 %)
Adjusted EBITDA margin 16.9 % 21.5 %
Net sales in Power Transmission for the three months ended June 27, 2020 were
$370.0 million , a decrease of 26.2%, or $131.5 million , when compared with prior
year period net sales of $501.5 million . Excluding the adverse impact of
movements in average currency exchange rates of $12.4 million , core sales
decreased by 23.7%, or $119.1 million , compared with the prior year period,
driven almost exclusively by lower volumes.
Net sales in Power Transmission for the six months ended June 27, 2020 were
$811.2 million , a decrease of 19.0%, or $189.8 million , when compared with the
prior year period net sales of $1,001.0 million . Excluding the adverse impact of
movements in average currency exchange rates of $21.9 million , core sales
decreased by 16.8%, or $167.9 million , compared with the prior year period,
driven almost exclusively by lower volumes.
Power Transmission's core sales declines in both the three and six months ended
June 27, 2020 were driven by lower sales to customers across all of our channels
as a result of a combination of weak demand and widespread shutdowns resulting
from measures taken in response to the COVID-19 pandemic. In particular, sales
to customers in the automotive channels declined significantly, driven by
weakness in North America and EMEA. Greater China provided modest growth in the
three months ended June 27, 2020 compared with the prior year period, primarily
from sales to our industrial customers, while the automotive end market in
Greater China also improved sequentially by 20.2% compared with the first
quarter of 2020.
Our Power Transmission Adjusted EBITDA for the three months ended June 27, 2020
was $57.7 million , a decrease of 45.4% or $47.9 million , compared with prior
year period Adjusted EBITDA of $105.6 million . The decrease in Adjusted EBITDA
was driven primarily by lower volumes of $49.9 million . Adjusted EBITDA margin
for the three months ended June 27, 2020 was 15.6%, a 550 basis point decline
from the prior year period Adjusted EBITDA margin of 21.1%, driven by the lower
volumes and the resulting lower fixed cost absorption.
Our Power Transmission Adjusted EBITDA for the six months ended June 27, 2020
was $137.2 million , a decrease of 36.3% or $78.3 million , compared with the
prior year period Adjusted EBITDA of $215.5 million . Adjusted EBITDA margin for
the six months ended June 27, 2020 was 16.9%, a 460 basis point decline from the
prior year period Adjusted EBITDA margin of 21.5%. Similar to the quarter, these
decreases compared with the prior year periods were driven by lower volumes and
the resulting lower fixed cost absorption.
Fluid Power (35.8% and 37.0%, respectively, of Gates' net sales for the three
and six months ended June 27, 2020 )
Three months ended
Period over
(dollars in millions) June 27, 2020 June 29, 2019 period change
Net sales $ 206.5 $ 308.4 (33.0 %)
Adjusted EBITDA $ 25.5 $ 59.8 (57.4 %)
Adjusted EBITDA margin 12.3 % 19.4 %
Six months ended
Period over
(dollars in millions) June 27, 2020 June 29, 2019 period change
Net sales $ 475.4 $ 613.8 (22.5 %)
Adjusted EBITDA $ 66.8 $ 115.4 (42.1 %)
Adjusted EBITDA margin 14.1 % 18.8 %
Net sales in Fluid Power for the three months ended June 27, 2020 were $206.5
million , a decrease of 33.0%, or $101.9 million , compared with net sales during
the prior year period of $308.4 million . Excluding the adverse impact of
movements in average currency exchange rates of $7.4 million , core sales
decreased by 30.6%, or $94.5 million , compared with the prior year period,
driven almost exclusively by lower volumes.
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Net sales in Fluid Power for the six months ended June 27, 2020 were $475.4
million , a decrease of 22.5%, or $138.4 million , compared with net sales during
the prior year period of $613.8 million . Excluding the adverse impact of
movements in average currency exchange rates of $11.6 million , core sales
decreased by 20.7%, or $126.8 million , compared with the prior year period,
driven almost exclusively by lower volumes.
The core sales decline in the three and six months ended June 27, 2020 was
driven primarily by lower sales to our industrial customers, across all regions,
except for Greater China , which grew in total by 6.8% during the three months
ended June 27, 2020 compared with the prior year period. The combination of weak
demand and widespread shutdowns resulting from measures taken in response to the
COVID-19 pandemic impacted all of our end markets, but particularly
construction, which declined during the three and six months ended June 27, 2020
by 41.4% and 27.9%, respectively, compared with the prior year periods.
Adjusted EBITDA for the three months ended June 27, 2020 was $25.5 million , a
decrease of 57.4%, or $34.3 million , compared with the prior year period
Adjusted EBITDA of $59.8 million . The decrease in Adjusted EBITDA was driven
primarily by lower volumes of $36.2 million . The Adjusted EBITDA margin
decreased by 710 basis points, driven by the lower volumes and the resulting
lower fixed cost absorption.
Adjusted EBITDA for the six months ended June 27, 2020 was $66.8 million , a
decrease of 42.1%, or $48.6 million , compared with the prior year period
Adjusted EBITDA of $115.4 million . The Adjusted EBITDA margin decreased by 470
basis points. Similar to the quarter, these decreases compared with the prior
year periods were driven by lower volumes and the resulting lower fixed cost
absorption.
Liquidity and Capital Resources
Treasury Responsibilities and Philosophy
Our primary liquidity and capital resource needs are for working capital, debt
service requirements, capital expenditures, facility expansions and
acquisitions. We expect to finance our future cash requirements with cash on
hand, cash flows from operations and, where necessary, borrowings under our
revolving credit facilities. We have historically relied on our cash flow from
operations and various debt and equity financings for liquidity.
From time to time, we enter into currency derivative contracts to manage
currency transaction exposures. Similarly from time to time, we may enter into
interest rate derivatives to maintain the desired mix of floating and fixed rate
debt.
As market conditions warrant, we and our majority equity holders, Blackstone and
its affiliates, may from time to time, seek to repurchase securities that we
have issued or loans that we have borrowed in privately negotiated or open
market transactions, by tender offer or otherwise. Subject to any applicable
limitations contained in the agreements governing our indebtedness, any such
purchases may be funded by existing cash or by incurring new secured or
unsecured debt, including borrowings under our credit facilities. The amounts
involved in any such purchase transactions, individually or in the aggregate,
may be material. Any such purchases may relate to a substantial amount of a
particular tranche of debt, with a corresponding reduction, where relevant, in
the trading liquidity of that debt. In addition, any such purchases made at
prices below the "adjusted issue price" (as defined for U.S. federal income tax
purposes) may result in taxable cancellation of indebtedness income to us, which
may be material, and result in related adverse tax consequences to us.
It is our policy to retain sufficient liquidity throughout the capital
expenditure cycle to maintain our financial flexibility. While we have seen a
decline in our business in the first half of 2020, and the duration and extent
of the impacts of the COVID-19 pandemic on our business are difficult to
predict, we do not currently anticipate any material long-term deterioration in
our overall liquidity position in the foreseeable future. Further, we do not
have any meaningful debt maturities until 2024 and we do not currently expect to
need to draw down under our committed lines of credit in the foreseeable future.
We therefore believe that as of June 27, 2020 , we have adequate liquidity and
capital resources for the next twelve months.
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Cash Flow
Six months ended June 27, 2020 compared with the six months ended June 29, 2019
Cash provided by operations was $71.6 million during the six months ended
June 27, 2020 compared with cash provided by operations of $63.8 million during
the prior year period. This increase was driven primarily by lower cash interest
and tax payments, offset partially by lower operating performance due to the
current demand environment. Interest paid was lower at $48.5 million during the
six months ended June 27, 2020 , compared with $80.0 million in the prior year
period, due primarily to the timing of quarterly interest payments on the term
loans as well as the absence of the usual biannual January interest payment on
the Dollar Senior Notes as a result of the refinancing completed in November
2019 . Net income taxes paid were also lower, with $16.6 million paid during the
six months ended June 27, 2020 compared with $61.9 million in the prior year
period, largely a function of refunds received and lower interim tax payments
based on the decrease in taxable profits.
Net cash used in investing activities during the six months ended June 27, 2020
was $37.1 million , compared with $47.5 million in the prior year. This decrease
was driven by lower capital expenditures, which decreased by $14.5 million from
$42.1 million in the six months ended June 29, 2019 to $27.6 million in the six
months ended June 27, 2020 .
Net cash used in financing activities was $18.9 million during the six months
ended June 27, 2020 , compared with $31.3 million in the prior year. This
decrease was driven primarily by an additional quarterly amortization payment on
our term loans in the prior year period due to the timing of our fiscal year
end. In addition, dividend payments of $15.0 million were made to
non-controlling shareholders of certain majority-owned subsidiaries in the prior
year period, compared with $9.9 million in the current period.
Indebtedness
Our long-term debt, consisting principally of two term loans and U.S. dollar
denominated unsecured notes, was as follows:
Carrying amount Principal amount
As of As of As of As of
(dollars in millions) June 27,2020 December 28, 2019 June 27,2020 December 28, 2019
Debt:
-Secured
Term Loans (U.S. dollar and Euro
denominated) $ 2,388.8 $
2,395.0
581.4 563.2 568.0 568.0
Other debt 0.2 0.2 0.2 0.2
$ 2,970.4 $ 2,958.4 $ 2,975.3 $ 2,985.0
Details of our long-term debt are presented in note 12 to the condensed
consolidated financial statements included elsewhere in this quarterly report.
Dollar and Euro Term Loans
Our secured credit facilities include a Dollar Term Loan credit facility and a
Euro Term Loan credit facility that were drawn on July 3, 2014 . These facilities
mature on March 31, 2024 . These term loan facilities bear interest at a floating
rate. As of June 27, 2020 , borrowings under the Dollar Term Loan facility, which
currently bears interest at LIBOR, subject to a floor of 1.00%, plus a margin of
2.75%, bore interest at a rate of 3.75% per annum. The Dollar Term Loan interest
rate is re-set on the last business day of each month. As of June 27, 2020 , the
Euro Term Loan bore interest at EURIBOR, which is currently below 0%, subject to
a floor of 0%, plus a margin of 3.00%. The Euro Term Loan interest rate is
re-set on the last business day of each quarter.
Both term loans are subject to quarterly amortization payments of 0.25%, based
on the original principal amount less certain prepayments with the balance
payable on maturity. During the six months ended June 27, 2020 , we made
amortization payments against the Dollar Term Loan and the Euro Term Loan of
$8.7 million and $3.7 million , respectively. During the six months ended
June 29, 2019 , we made amortization payments against the Dollar Term Loan and
the Euro Term Loan of $13.0 million and $5.5 million , respectively.
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During the periods presented, foreign exchange (losses) gains were recognized in
respect of the Euro Term Loans as summarized in the table below. As a portion of
the facility was designated as a net investment hedge of certain of our Euro
investments, a corresponding portion of the foreign exchange (losses) gains were
recognized in other comprehensive income ("OCI").
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